Submitted by: Amy Vincent

Fraud and schemes have plagued the stock market since its inception. It is too alluring for some to resist trying to get an undeserved piece of the large amounts of money moved around on the market. Cleverly disguised, fraudulent schemes must always be anticipated and monitored for accordingly. Throughout the stock markets history numerous rules and regulations have been enacted in attempt to deter deceptive practices, but as the adage goes, where theres a will, theres a way.

In todays world there are many rules and regulation in place to protect investors against fraud, but there are always loopholes and gaps that allow for some to cheat the system. There is a regulation in place, the 1996 Securities Market Improvement Act, which determines whether securities should be monitored at a state or federal level, but is this current system effective in monitoring and protecting investors against fraud?

Supervision and Acts

To understand where these securities rules and regulations come into play, it is important to understand their history. A great place to begin is at the lowest point of Americas stock market history, the infamous crash.

Shortly after the stock market crash of 1929, the U.S. Congress passed two momentous proposals in effort to regulate the stock market and protect investors against fraud, The Securities Act of 1933 and the Securities Exchange Act of 1934.

A regulatory body, called the Securities and Exchange Commission or SEC, was created by section 4 of the Securities Exchange Act of 1934 as an independent agency of the United States government. The SEC was formed to regulate and enforce federally established securities laws and served to establish a government-supervised financial industry. The goal of the SEC was to restore investor confidence in the turbulent and oftentimes fraudulent post-crash marketplace.

While the SEC monitored and regulated securities on a federal level, individual states also enforced statewide securities regulation, to combat fraud at a local level. These state enforced rules and regulations are termed, Blue-sky laws. Blue-sky laws regulate the offerings and sales of securities within a certain state to protect investors against fraud. Most of these laws require securities to be registered at a state level prior to being sold within the state.

Dual Regulation Woes

While registering securities at both state and federal levels served to regulate against fraud at two levels, federal securities laws and state Blue-sky laws oftentimes not only duplicated one another, but added a bit of a headache to the registration and regulation processes as well.

As a first step toward highlighting the need to do away with dual regulations, The Revised Uniform Securities Act of 1985 or RUSA was enacted. RUSA did not remove state-level security registration processes, but it served to prepare for legislative activity that would. It also included an exception on registering securities traded on NASDAQ at a state level, which most states passed in to law between 1985 and 1990.

To further deal with the confusion and other issues that dual regulation caused, in 1996, the US Congress passed the National Securities Market Improvement Act or NSMIA, which amended Section 18 of the 1933 Act. This Act applies to securities listed on the American Stock Exchange, the New York Stock Exchange, and NASDAQ.

NSMIA

NSMIA was adopted as an attempt to create a federally controlled, uniform securities registration code to follow. The code eliminated the need for securities owners of nationally traded stocks and mutual funds to register at both state and federal levels, and thereby pre-empted all state Blue-sky laws. NIMSA did however, preserve states rights to maintain anti-fraud authority over all securities traded within its borders.

While the ability of states to prosecute violations of state-based securities antifraud statutes was left intact, states lost control over much of their securities regulatory authority. This loss of state control can be seen well in the investment advisor arena as NSMIA specifically removed states power to regulate securities controlled by investment advisers with Assets Under Management or AUM, totaling over 25 million dollars (including private placements) instead placing them under regulation of the SEC.

Loopholes

Since everything was so simple as to who would govern securities and registration, things were much easier and fraud was reduced, right? Well to a certain degree it was, but there are of course loopholes to the NIMSA act, such as Regulation D Rule 506 offerings, which are exempt from registration requirements.

Regulation D allows for the sale of securities to be exempt from registration with the SEC, if one of three rules are met and as long a company files a Form D with the SEC after their securities are sold. Form D is notice that contains the names and contact information about a companys CEOs and stock promoters, but little else.

Regulation D companies that also use the Rule 506 exemption can raise unlimited amounts of money without ever registering with the SEC, and since NSMIA, they are not regulated by the states either, so they enjoy basically no regulatory scrutiny.

This lack of regulation has opened the door to fraud and many argue that it could be easily stopped in its early stages if states were given more regulatory powers.

Should state regulatory ability be re-instated?

There have been discussions by states securities officials that there should be a legislative reform effort to revise state and federal regulatory authority. If states were permitted to exercise regulatory enforcement to address fraud in the beginning stages, then it could be stopped before investors suffer significant losses.

The North American Securities Administrators Association President, Fred Joseph has urged for the adjustment of the AUM or Assets Under Management from 25 million to 100 million arguing that even small investment advisors typically manage more that 25 million. He has also asked that Congress increase state authority to enforce regulation over large investment advisors to counter fraud.

Overall, the arguments seem to be that states should be able to have increased authority to screen for securities fraud at its earlier level when there may just be evidence of slightly deceptive practices instead of downright fraud. This early detection could save investors from the harm of unregulated securities fraud.

About the Author: By Amy Vincent, sponsored by First American Stock Transfer, Inc., registered with the Securities & Exchange Commission as a

Registrar and Stock Transfer Agent

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